In recent years there has been increasing concern about how little Americans save compared to how much they spend. In fact, the U.S. Commerce Department reported that for the year 2005, the personal savings rate of Americans fell into negative territory for the first time since the Great Depression in 1933. Perhaps this should not be surprising considering that the number of commercial messages to spend and consume vastly outnumber those to save and invest. In any case, the increasing propensity of Americans to spend more than they save is a troubling trend.
Also in recent years, there has been discussion about the future long-term viability of the U.S. Social Security system as more Americans live longer and longer lives. However, regardless of its future viability, the Social Security system was never intended to provide complete financial independence for its recipients, but instead was only intended to provide an economic “safety net.” Thus, Americans who spend more than they save in the belief that Social Security alone will provide for their desired standard of living may be in for a rude awakening as they near retirement age.
One reason that many Americans spend more than they save is that they do not truly understand or are unable to easily measure their own financial status. Although displays of wealth such as the size of one's home or the year and make of one's car have effectively become subjective measures of consumer status, this tells an individual almost nothing about their financial status and their progress toward a financial goal. Likewise, although a credit score (such as the FICO® score by Fair Isaac Corp., Minneapolis, Minn.) provides a simple objective measure of an individual's credit worthiness, this information similarly tells the individual very little about their financial status relative to a financial goal. Without a simple objective measure of financial status, many Americans continue their spending habits in blissful ignorance of the earnest need to begin a savings plan.
While financial professionals, such as Certified Financial Planners, are equipped to give advice on how to reach a financial goal, only a small percentage of Americans actually seek out their help. One reason for this reluctance may be that, without a readily available objective measure of their financial status, many people do not realize how immediate and serious the need to implement a savings plan actually is. Accordingly, many individuals do not seek out professional financial advice until after they understand their financial status, but they do not truly understand their financial status until after they seek out professional financial advice. Thus, if individuals were able to objectively quantify their financial status without first seeking out professional financial advice, it is likely that many more people would realize the immediate importance of creating a savings plan, and therefore it is also likely that many more people would then seek out professional financial advice.
One difficulty in quantifying financial status relative to a financial goal, is the fact that the future is uncertain. Even if a given class of investments has a stable average historical rate of return, there is no guarantee that in any one year the rate of return will be equal to or even close to the average historical rate. Thus, a deterministic calculation of the future value of an investment based on an average historical rate may not be an accurate prediction, particularly where the actual rate of return in the first few years is drastically different from the average rate of return.
In order to overcome the difficulties associated with making deterministic predictions about an uncertain future, it is well known in the art to use modeling techniques generally known as Monte Carlo methods or simulations. In a Monte Carlo simulation of the future value of an investment (or portfolio of investments), historical data on the investment's rate of return is generally fitted to a probability distribution. Based on the probability distribution, possible rates of return are generated for a plurality of intervals (such as one year) within a given period of time. Essentially, a Monte Carlo simulation of the value of an investment models a large number of possible paths the value of an investment can take over a period of time (with the rate of return varying for each of the plurality of intervals within the period), and then predicts the probability that the value will reach a certain threshold value by the end of that period. The larger the number of paths simulated, the more accurate the prediction will be.
Thus, a Monte Carlo simulation of the value of an investment basically creates a large number of simulated investments, and models them over a period of time, accounting for varying rates of return over the simulated time period. Depending on when (i.e. in what year of the time period) and how much the rates of return depart from average, some of the simulated investments will reach the threshold value by the end of the time period and some will not. By comparing the number of simulated investments that reach the threshold value to the number of those that do not, a probability that an actual investment will achieve the threshold value in real life can be determined. Accordingly, a Monte Carlo simulation accounts for the inherent uncertainty in the future in a way that a deterministic simulation cannot.
Systems and methods exist for using Monte Carlo methods to determine the probability that an investment will reach a threshold value by the end of a period of time. For example, U.S. Pat. No. 7,031,935 discloses such systems and methods. However, the systems and methods disclosed therein only determine the probability of an investment attaining a certain value; they do not provide information about an investor's probable financial status relative to a financial goal. The probability of achieving a financial goal is not the same as a measure of one's progress toward a financial goal, because the latter lets the individual know whether they are saving at a sufficient rate to achieve their goal.
In summary, without a simple objective measure of financial status, very few Americans are aware of their actual progress relative to a financial goal, such as retirement or financial independence. If equipped with a firm understanding their financial status relative to a financial goal, many people would objectively understand the importance of saving for the first time, and would therefore begin saving in earnest much sooner than they otherwise would have. Accordingly, there is a need for a simple objective measurement of an individual's financial status relative to a financial goal, such as financial independence.